It was the first step towards regulating the virtual currency, which has seen a surge in value because of its popularity with mainland investors.

The People's Bank of China (PBOC) said no financial institutions, payment agencies or insurers should price products and services in bitcoin, nor are they allowed to trade or provide bitcoin exchange or settlement services. The announcement follows a near 90-fold increase in the virtual currency's value since it was created in 2009.

The rally has been caused largely by demand in China, with traders from mainland banks joining technology fans and speculators to invest in bitcoin.

Bitcoin's price slumped to below US$1,000 on major trading platforms after the announcement. It was trading at US$980 in the afternoon on BitStamp, down sharply from US$1,138.58 the day before.

On the Shanghai-based BTC China exchange, it was trading at 4,785 yuan (HK$6,053), compared with 7,050 yuan on Wednesday.

"Bitcoin is a bubble that will burst sooner or later," said Zhao Xijun, a finance professor at Renmin University. "Firewalls are necessary to separate risks in the virtual world from the real economy before it's too late."

Bitcoin is not a currency with "real meaning" and does not have the same legal status as a currency, the PBOC said. It said trading was highly speculative, hard to monitor and prone to manipulation by criminals.

The PBOC will closely monitor the money-laundering risks stemming from the virtual currency, which can be traded anonymously and could circulate across the border, it said.

However, the central bank said the public was free to take part in internet transactions provided they take on the risk themselves. Internet companies serving as trading platforms should ask clients to register with information including their name and identity card number, it said.

China has become the world's biggest trader of the virtual currency, accounting for more than half the global transactions, according to BTC China.

Investors have turned to the globally tradeable bitcoin amid a sluggish domestic stock market and curbs on various other forms of investments. Bitcoin also makes it easy to convert the yuan to invest in equities and properties overseas and evade taxes.

Last month a US Justice Department official said bitcoins could be a "legal means of exchange", boosting the prospect of the virtual currency gaining wider acceptance.

Video: What's Bitcoin and how does it work?

This article appeared in the South China Morning Post print edition as: